Advanced Accounting
by Debra Jeter and Paul Chaney
Chapter 6: Elimination of Unrealized
Profit on Intercompany
Sales of Inventory
Slides Authored by Hannah Wong, Ph.D.
Rutgers University
6-0
Intercompany Sales of Inventory
Parent Company
Downstream Sale
Upstream Sale
Subsidiary
Subsidiary
Horizontal Sale
obj 1
6-1
Financial Reporting Objectives
Consolidated sales = sales with parties
outside the affiliated group
Consolidated COGS = cost to the
affiliated group of goods that have been
sold to outside parties
Consolidated inventory = inventory at
its cost to the affiliated group
obj 1
6-2
Financial Reporting Objectives
To present
consolidated balances
of sales, cost of sales,
and inventory as if the
intercompany sale
had never occurred.
obj 1
6-3
Downstream Sales :
No Unrealized Profit
Outsider
Supplier
Purchased
for
$200,000
Parent
Company
Sold for
$250,000
Sold for
$270,000
Subsidiary
obj 2
Outside
Customer
6-4
Downstream Sales
No Unrealized Profit - EE
Sales
250,000
Purchases
To eliminate
intercompany sale
that the parent
has recorded
obj 2
250,000
To eliminate intercompany
purchase that the
subsidiary has recorded
6-5
Downstream Sales:
Unrealized Profit in Ending Inventory
Outsider
Supplier
Purchased
for
$200,000
Parent
Company
Sold for
$250,000
Note: it is the parent who
records the intercompany
profit, thus the parent’s
income needs to be
adjusted in consolidation
obj 2
Sold 60%
of goods
Subsidiary
Outside
Customer
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Downstream Sales - EE
Year of Intercompany Sale
Sales
250,000
Purchases
250,000
To eliminate intercompany sale and purchases
Ending Inventory - Inc. state. (COGS)
Inventory - balance sheet
To exclude the unrealized
profit from consolidated
net income
obj 2
20,000
20,000
To exclude the unrealized
profit from ending inventory
6-7
Downstream Sales - EE
Year after Intercompany Sale
Cost or Partial Equity Methods
Beginning R/E - P
20,000
Beginning Inventory - Inc. State. (Cost of sales)
20,000
The intercompany profit in
beginning inventory is
excluded from last year’s
consolidated NI, hence
this year’s 1/1 R/E
obj 2
To include the intercompany
profit in beginning inventory,
which is realized
in the current year
6-8
Downstream Sales - EE
Year after Intercompany Sale
Complete Equity Method
Investment in S
20,000
Beginning Inventory - Inc. State. (Cost of sales)
20,000
The intercompany profit in
beginning inventory is
excluded from last year’s
consolidated NI, hence
the investment account
obj 2
To include the intercompany
profit in beginning inventory,
which is realized
in the current year
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Amount of Intercompany Profit
Gross profit method
intercompany profit that should be eliminated
= ending inventory of buying affiliate
x selling affiliate’s gross profit rate
(i.e., gross profit / cost)
obj 2
6 - 10
Elimination of Downstream
Intercompany Profit
100% elimination
the parent’s and the noncontrolling
stockholders’ portion of intercompany profit
 eliminate
despite partial ownership of the parent
 required
by current GAAP
Partial elimination
only the parent’s portion of
intercompany profit
 eliminate
obj 3
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Upstream Sales
Outsider
Supplier
Purchase
Note: it is the subsidiary
who records the
intercompany profit, thus
the subsidiary’s income
needs to be adjusted in
consolidation
obj 4
Subsidiary
Intercompany
Sale
Parent
Company
Sell
Outside
Customer
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Upstream Sales
An Example
Profit margin
= 25%
x selling price
obj 4, 5
80% owned
Subsidiary
Total sales
$700,000
Parent
Company
$400,000
intercompany
merchandise in
ending inventory
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Upstream Sales
Cost or Partial Equity Methods
Year of Intercompany Sale - EE’s
Sales
700,000
Purchases
700,000
To eliminate intercompany sale and purchases
Ending Inventory - Inc. state. (COGS)
Inventory - balance sheet
To exclude the unrealized
profit (400,000x25%)
from consolidated
net income
obj 4, 5
100,000
100,000
To exclude the unrealized
profit from ending inventory
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Upstream Sales - EE
Cost or Partial Equity Methods
Year after Intercompany Sale - EE’s
Parent’s share of unrealized
profit in beginning inventory
Beginning R/E - P ($100,000x80%)
80,000
Beginning R/E - S ($100,000x20%)
20,000
Beginning Inventory - Inc. State. (Cost of sales)
100,000
Noncontrolling interests’ share
of unrealized profit in
beginning inventory
obj 4, 5
To include the intercompany
profit in beginning inventory,
which is realized
in the current year
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Cost or Partial Equity Methods
Noncontrolling Interest in Income
Reported income of S
Upstream-sale profit in
ending inventory
Upstream-sale profit in
beginning inventory
Adjusted NI of S
x Noncontrolling %
Noncontrolling interest in income
obj 4, 5
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Cost and Partial Equity Methods
Controlling Interest in Income
Downstream-sale profit
in ending inventory
Amortization of purchase
differential
Reported income of P
Downstream-sale profit
in beginning inventory
(Adjusted NI of S) x (P %)
Consolidated income
obj 4, 5
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Cost and Partial Equity Methods
Consolidated Retained Earnings
P% x (Upstream-sale profit
in P’s ending inventory)
Downstream-sale profit
in S’s ending inventory
Accumulative amortization
of purchase differential
Reported R/E of P
P’s share of increase in
S R/E since acquisition
Consolidated R/E
obj 4, 5
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Upstream Sales
Complete Equity Method
Year of Intercompany Sales - Journal Entries
Equity in subsidiary income
Investment in S
80,000
80,000
To exclude the unrealized profit (400,000x25%)
from equity in subsidiary income
obj 4, 5
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Upstream Sales
Complete Equity Method
Year after Intercompany Sales - Journal Entries
Investment in S
Equity in subsidiary net income
80,000
80,000
To include in equity in subsidiary income the intercompany
profit, which is realized in the current year
obj 4, 5
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Upstream Sales
Complete Equity Method
Year of Intercompany Sales - EE’s
Sales
700,000
Purchases
700,000
To eliminate intercompany sale and purchases
Ending Inventory - Income Statement
Inventory - Balance Sheet
100,000
100,000
To exclude the unrealized profit (400,000x25%)
from equity in subsidiary income
obj 4, 5
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Upstream Sales
Complete Equity Method
Year after Intercompany Sale - EE
Parent’s share of unrealized
profit in beginning inventory
Investment in S
Beginning retained earnings - S
1/1 Inventory - Income Statement
Noncontrolling interests’ share
of unrealized profit in
beginning inventory
obj 4, 5
80,000
20,000
100,000
To include the intercompany
profit in beginning inventory,
which is realized
in the current year
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Upstream Sales
Complete Equity Method
Consolidated net income
= Reported net income of Parent
Consolidated retained earnings
= Reported retained earnings of Parent
obj 4, 5
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Add Excel for L06
obj 6
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Preaffiliation Profit
Should We Eliminate?
GAAP is silent as to elimination of
preaffiliation profit.
If selling company is the subsidiary, the
retained earning is eliminated in
consolidation.
If selling company is the parent,
elimination would cause double
counting of profit.
obj 7
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Advanced Accounting
by
Debra Jeter and Paul Chaney
Copyright © 2003 John Wiley & Sons, Inc. All rights reserved.
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